An investor who thinks the price of a security will drop in the future can try to profit from this belief by selling short. To sell short, an investor borrows securities, sells them, and then repurchases the securities in the future (the investor hopes at a lower price) to return to the lender. If successful, the short seller pockets the difference minus any trading costs.
An investor who thinks the market, or a particular security, is going to decline in value is said to be bearish. Therefore, selling short would be a bearish position.
Note: The maximum loss a bullish investor (an investor who goes long) can have is the price of the security. The maximum loss a short seller can have is theoretically unlimited, due to the unknown levels to which the price of a security may rise.
An investor must open a margin account to sell short and must deposit at least 50% of the short market value of securities. The accountholder must keep at least 30% of the short market value (SMV) in equity in the account. This is the minimum maintenance requirement. In addition, the customer must always maintain at least $2,000 in a short account.
The relevant equation is:
credit balance – SMV = equity
Since the customer has the proceeds of the short sale in the account and must also deposit 50% of the SMV of the securities, the customer’s initial credit balance is 1.5 times the SMV. The 50% deposit is meant to cover half of the value of the securities when the investor is required to buy them back in the market to return to the lender.
Example: Suppose Candy Rollins shorts 1,000 shares of XYZ Corporation. XYZ is currently trading at $30 per share.
SMV = $30,000; this short market value represents the proceeds of the stock that was borrowed and sold.
Regulation T requires an additional deposit of $15,000 to cover the 50% initial margin requirement.
